In a single generation Vietnam has gone from being one of the poorest nations to lower middle-income. The remarkable transformation is in no small part to the country’s opening up to the global economy. But as Francesco Abbate and Luciana Chiaravalli write, this has a bright and dark side.
As Christine Lagarde, Managing Director of the International Monetary Fund recently said, “in a single generation, Vietnam moved from being one of the world’s poorest nations to lower middle-income status, from a heavy reliance on commodities to manufacturing excellence, from economic stagnation to relentless dynamism.”
The country’s gradual integration into the global and regional economies over the past 30 years has helped stimulate this success. This integration is the result of a vigorous policy of openness to trade and foreign direct investment (FDI) flows pursued by the Vietnamese Government at multilateral, regional and bilateral levels.
Since 1986, the country has undertaken a number of far-reaching political and economic reforms within the framework of Doi Moi, or renovation, which constituted an epochal shift towards a mixed economy system. The first investment law was enacted in 1987, and in 1993 the country renewed its relations with international financial institutions.
In 1995, Vietnam became a full member of ASEAN, committing itself to the implementation of the ASEAN Free Trade Area (AFTA) and, more recently, the ASEAN Economic Community (AEC). The country also participated in ASEAN agreements establishing free trade areas with Australia and New Zealand, China, India, Japan and South Korea.
Vietnam’s integration within ASEAN has served as a jumping board for wider liberalisation efforts. In 2007, the country joined the World Trade Organization, following a long accession process which started in 1996.
Over the last three decades, Vietnam implemented key legislative and economic reforms, in addition to reducing or eliminating tariffs and non-tariff barriers, state trading monopolies and subsidies to public enterprises. The average tariff imposed on imports from WTO members sharply dropped from 18 per cent in 2007 to 10 per cent in 2013.
In the past two years, Vietnam has concluded a number of “new generation” free trade agreements (FTAs) — including clauses on foreign direct investment (FDI), competition policy, public procurement and e-commerce — with its key trading partners: South Korea, Eurasian Economic Union led by Russia, European Union and 12 countries within the Trans-Pacific Partnership, including the United States, Canada and Australia.
Regarding FDI liberalisation, Vietnam signed bilateral investment treaties with as many as 62 countries. The new investment law, which entered into force in 2015, not only streamlined FDI approval procedures but, more importantly, reduced the number of activities closed to foreign investors from 51 to six, and authorized foreign ownership of Vietnamese firms up to 100 per cent.
The bright side
Growing integration of the Vietnamese economy is mirrored by its trade openness rate — the ratio of trade (exports plus imports of goods and services) to GDP. In 2014, this reached the level of 161 per cent — the highest among ASEAN countries, with the exception of Singapore.
More specifically, exports of goods and services jumped from US$ 27 billion in 2004 to US$ 160 billion in 2014, registering an average annual growth rate of 19 per cent and rapidly recovering after the 2009 slump triggered by the international financial crisis. The United States and the European Union are the most important destinations, followed by ASEAN, which, however, has experienced a higher expansion rate than the other two markets over the past 10 years.
Staggering export growth was accompanied by structural transformation in which electronics – in particular mobile phones – has played a key role. Since 2011 it has been Vietnam’s leading export sector, overtaking ASEAN competitors such as Thailand and the Philippines, and perhaps Singapore in the near future.
Another significant export sector is textiles and clothing, in which there are about 6,000 firms employing some 2.5 million workers. This sector is expected to benefit greatly from the TPP (which will dismantle customs barriers imposed by the US, the largest export market) and the FTA with the EU, the second destination.
It is also worth mentioning the important role played by agriculture with key products, such as coffee and rice, of which Vietnam is among the biggest world exporters and the fisheries sector employing as much as 10 per cent of the labour force.
At the same time, trade liberalisation stimulated a surge in imports of goods and services, which, over the past 10 years, grew at annual rate of 16.5 per cent, albeit somewhat lower than exports. Among the supply markets, China captured the lion’s share accounting for 30 per cent of merchandise imports in 2014 – followed by ASEAN and South Korea.
Interestingly, the most important category in the import bill is electronics (23 per cent of the total), as in the case of exports. However, on the import side it is about components, mostly integrated electronic circuits from China or South Korea, which are assembled to manufacture export products. This is the most tangible aspect of Vietnam’s insertion into regional value chains.
Another key indicator of Vietnam’s economic integration is FDI inflows, growing from about US$ 2 billion in 2005 to roughly US$ 12 billion in 2015. This is a new record for Vietnam, which now occupies the sixth position among Asian FDI destinations, surpassing Malaysia and Thailand. In terms of FDI stock, at the end of 2014 the most important home countries were South Korea, Japan, Singapore and Taiwan.
FDI has constituted the driving force for the country’s industrialisation process. The share of manufacturing in GDP jumped from 19 per cent in 1995 to 38.5 per cent in 2014, spurred by foreign enterprises, which in 2014 accounted for 15 per cent of GDP and more than 1.7 million jobs.
Among the most important factors determining Vietnam’s attractiveness to foreign investors is, in the first place, its low labour cost compared to China’s and that of most ASEAN countries, followed by its geographic proximity to China, which facilitates imports of raw materials and components into the country.
Furthermore, Vietnam offers the so-called 3Ds: durable macroeconomy, domestic consumption and demographic dividend — that is macroeconomic stability, a domestic market with 94 million consumers and high growth potential, and a relatively young labour force.
Vietnam is not only a major FDI host country but is also increasing its FDI outflows, which reached US$1.1 billion in 2015. The main host countriesare Tanzania, Cambodia and Burundi, while the key sectors are oil and gas, agriculture, hydropower and ICT.
The dark side
Despite the huge benefits Vietnam has reaped from its integration into the global and regional economies over the past 20 years, there remain, however, three critical issues requiring special attention by the country’s economic policymakers.
The first is the lack of upstream and downstream linkages between FDI and Vietnamese firms.
Vietnam has become a new global manufacturing hub for highly labour-intensive activities mostly involving assembly of parts and components either imported or locally manufactured by foreign firms. As an example, out of 90 firms supplying components to Samsung, a mere seven are Vietnamese firms only providing moulds or packaging products.
The paucity of linkages with local enterprises is not only the main cause of the low value added of exports but also does not favour technology transfer.
Second is low labour productivity, which is well below that of the most advanced ASEAN countries. This is shown by the lack of skilled workers and managerial capacities.
In addition to low productivity in agriculture, which still provides employment to 47 per cent of the labour force, SOEs are a significant source of inefficiency. The partial privatisation of SOEs, generating as much as one-third of GDP and accounting for 15 out of Vietnam’s 20 largest firms, is proceeding at a slow pace. Equally slow is the restructuring of the banking system, which suffers from a worrying level of non-performing loans.
Third is high corruption level, which constitutes a heavy “transaction cost” for the country’s further integration into the global economy.
According to Transparency International, Vietnam ranks 112th among 168 countries in the Corruption Perceptions Index. This critical situation is confirmed by a World Bank survey for constructing the Worldwide Governance Indicators, which include corruption control.
With regard to this variable, in 2014, Vietnam was rated 126th among 200 nations — a position that unfortunately has remained virtually stable over the past 20 years.
It would seem that in the immediate future things will remain dark as much as they brighten.
Mr Francesco Abbate is Adjunct Professor of International Economics at the Law Department of the University of Turin, Italy. Ms Luciana Chiaravalli is an international business consultant and expert in international economics.
This article is a translation from Italian and based on a paper published in RISE — a publication on Southeast Asia from the Torino World Affairs Institute (Twai).